Nestlé’s position in the US frozen-food market has been the subject of debate for a number of years amid a chequered performance in the category. And question marks persist, writes Dean Best.
It’s coming up to a decade since Nestlé stocked up its freezer cabinet in the US with the US$3.7bn acquisition of the then Kraft Foods’ frozen-pizza business.
At the time, the world’s largest food maker said the eye-catching deal would give its US frozen-food portfolio a new “strategic pillar”. Speaking to just-food when the acquisition was announced, a Nestlé spokesperson pointed to the “consistent growth” there had been in the US market for frozen prepared food over the prior 15 years “with a growth rate of over 5% per year”.
However, almost ever since, Nestlé has regularly faced questions from the investment community about whether it should be doing business in US frozen food. And those questions persist.
“US Frozen has been a high-profile headache for Nestlé for most of the last decade,” Sanford Bernstein analyst Andrew Wood said in a note to clients in May. “After five years of sales declines and share losses from 2010 to 2014, management made a significant public effort to turn this business around in 2015, with some signs of success in 2015 to 2016. However, while 2017 to 2018 saw a market recovery (+3.5% in 2018), Nestlé continued to suffer declines (-0.4%) and it lost triple-digit basis-point market share in most periods.
“While the level of Nestlé’s share loss has been curtailed, it is still losing share. Nestlé’s growth in frozen pizza and frozen sandwiches has been positive, while frozen entrées has been weak, matching market momentum – but Nestlé is still losing market share in all three segments.”
In the main, Nestlé’s US frozen pizza business has performed more solidly than other parts of the division. The pizza stable, which includes the DiGiorno, Tombstone and Jack’s brands, has, since 2010, had years when sales have declined – but, in the round, its performance has been less chequered than other parts of Nestlé’s frozen operation Stateside.
A mixed showing
At times during the past nine-and-a-half years, Nestlé’s wider US frozen-foods business – home to brands including Stouffer’s, Hot Pockets and Lean Cuisine – has seen its sales come under pressure, with the Swiss food giant pointing, in the early part of the 2010s, to a challenging economic environment in the country or, as we moved into the middle of the decade, the problem of changing how American consumers viewed frozen food.
By 2014, as Nestlé offloaded other brands in its portfolio, some industry watchers started to speculate, for example, some US frozen-food brands might be next on the block. At the start of 2015, the company embarked on a series of projects on each of Stouffer’s, Hot Pockets and Lean Cuisine, investing in reformulation, innovation and marketing in a bid to “reposition” the brands and make them more relevant to consumers. “It is a category and a business for us that is a challenge,” then CEO Paul Bulcke said in February 2015 as he discussed Nestlé’s 2014 financial results. “The category has decreased over the last years by 2% to 3% every year.”
However, he added: “It is a fantastic category because, first of all, it is part of the North American landscape. It has huge penetration; Nestlé and our brands, too. It is a very sizeable business – a CHF23bn business – and it is projected to be growing by 2% to 3% for the next years to come.”
When Nestlé reported its 2015 and 2016 financial results, it made some positive noises about the performance of its US frozen-food business. In February 2016, the company saw its sales growth in North America overall accelerate, led by what it said at the time had been a “turnaround” in frozen due to innovation. “We at Nestlé are true believers in this category,” Bulcke said. Reporting its 2016 results a year later, CFO François-Xavier Roger said Nestlé’s North American business had seen its highest growth for seven years, a performance “largely supported” by frozen food.
However, the frozen-food division put in something of a mixed showing in 2017 and some market analysts had again started to question whether a company that had quit the category in some markets in Europe should stay in the business on the other side of the Atlantic. At Nestlé’s 2017 investor day, recently-installed CEO Mark Schneider insisted the group had “a strong commitment” to frozen food in the US.
“I know with some of you there was a perennial question about when we were getting out of this. Unjustly, this business has a bad reputation from the past when maybe some of the food offerings were not exactly Nestle health and wellness,” Schneider said. “In frozen, it’s not about the delivery, it’s about what you put in. If you freeze healthy products, you get healthy products. The whole notion of vilifying a whole supply chain does not make sense.”
Reporting Nestlé’s 2017 results in February 2018, Roger described US frozen meals as “positive” but Hot Pockets and pizza “negative” amid pressure on the “mainstream” parts of those categories.
And in February this year, discussing Nestlé’s results for 2018, the company’s management said the sales performance of its US frozen-food division had been “flat”, with pizza in growth but other parts of the range not. “When it comes to frozen meals, we did not have a good year and we just own up to that,” Schneider said. “It was very clear that what we’ve done in prior years was too much of a one shot type of improvement on the old innovation model. What we really have to apply now is this continuous improvement, basically hit the market all the time with new and improved products and stay ahead.”
Nestlé appeared to have some better news in April, when it provided a trading update for the first three months of 2019. “Frozen food returned to positive growth led by the Hot Pockets and Stouffer’s brands,” Roger told analysts, pointing to innovation and “better execution”.
Schneider was more fulsome in his praise. “We are getting traction on Stouffer’s, we are getting more traction on Hot Pockets. Pizza … was never as much of a problem. Pizza continues to run with positive growth and we have some very exciting initiatives underway. Lean Cuisine will still take a little more time to get traction but I am as confident as I am for the rest of frozen that the team is actually making good progress. I tip my hat to the amazing work that is going on,” he said. “When it comes to that category overall we are seeing renewed interest, especially from younger shoppers, so I think these efforts are worthwhile and it is important and good work for the company to defend our market position in this category.”
However, Sanford Bernstein’s Wood said the improvement Nestlé has seen “does not really justify the positive tone on the return to growth in the Q1 sales call”.
He added: “This reminds us of Unilever’s overly-positive tone whenever its spreads business saw growth, as if one or two quarters could hide chronic problems or years of declines. We wonder if Nestlé may have a similarly blinkered approach to US frozen food. We continue to believe that a strategic review/disposal of US frozen food should be one of the steps of Schneider’s ‘quiet revolution’ but, as with Unilever and spreads, it may take time.”
Analysts can often call for companies the size of Nestlé and Unilever to look to offload under-performing assets – and sometimes CEOs can dismiss the comments out of hand. Asked to comment for this article, Nestlé said it would not comment on “analysts speculations”. A spokesperson added: “Frozen is a growing, healthy and attractive category in the US and we are committed to driving growth in this space. We are doing this by actively working on our innovation pipeline, accelerating key growth platforms with brands like Sweet Earth, and strengthening consumer favorites like Häagen-Dazs and DiGiorno.”
Ioannis Pontikis, an equity analyst covering European consumer stocks at financial-services firm Morningstar, says Nestlé “genuinely believes that it can win in frozen food”. He points to Nestlé’s announcement last month of changes to its frozen-food distribution model in the US as one way the company could save costs, improve margins and allow for further investment in areas like innovation.
However, Pontikis adds: “That said, we shouldn’t rule out a potential sale of the division in case organic growth doesn’t live up to expectations in the years ahead. The transition to a warehouse model will make the business leaner and less complex, which will improve multiples Nestle could achieve in a potential divestment. This is exactly what CEO Schneider has alluded to many times in the past: he favours fixing the business first before selling it, which leads to higher prices achieved for the divested entities.”
When weighing up whether Nestlé could one day sell its US frozen-food business, one analyst argues some parts of the division could deserve to be kept.
“I think you have to differentiate a little bit. The total [division] I wouldn’t really sell,” Alain Oberhuber a consumer goods analyst for German bank MainFirst, tells just-food. “For sure, they should get out of the Hot Pockets business, Stouffer’s probably as well. Two years ago, if you had asked me, I would have said they should sell the pizza business as well. Recently, after the heavy investments they have done and some articles I have read about demand [for pizza] from millennials, there could be an investment case behind that. The jury on pizza is still out.”
Oberhuber argues the changes to how Nestlé will distribute frozen food in the US could be seen as “the first step” for the company to exit the category “maybe down the road in total” but suggests any exit could be done in stages, rather than in one go. And, even though Nestlé reports ice cream outside of its wider frozen-food business in the US – and consequently much of the discussion among analysts and the investment community does not cover the future of US ice cream – Oberhuber suggests the company could make disposals in that category, too.
“They might keep obviously Haagen-Dazs for a moment, as well as some of the other brands, but in particular Edy’s and Dreyer’s, they could be one of the first to go after they close down the direct-store delivery in the US,” Oberhuber says.
“You can look at the ice cream business in the US in three categories: the super-premium business of Haagen-Dazs, which is doing very well at the moment, growing at about 5%; you have Drumstick, which is doing OK; and you have Dreyer’s/Edy’s – there I guess they will head first because they realise ice cream per se is not a category, which you can manage very well on return on capital employed basis because it is heavy asset-based.”
Four years ago, Nestlé put much of its ice-cream business into an international venture with the private-equity firm PAI Partners, which owns UK-based R&R Ice Cream. Nestlé’s US ice-cream arm was left out of the venture, called Froneri. The Israeli ice-cream unit of Nestlé was also held back but there has been speculation in recent weeks about whether that could head to the venture.
Oberhuber adds: “If you ask what is the picking order down the road in the next 12 to 18 months, I expect Edy’s will be divested pretty soon after the closure of DSD. Then I expect the Hot Pockets business and Stouffer’s will be divested afterwards and then there is obviously a question mark what will happen to the pizza business and how successful they are.”
It seems Nestlé’s US frozen-food business will remain the subject the debate as we enter the next decade.